1. Copyright 2002, Pearson Education Canada1 General Equilibrium and the Efficiency of Perfect Competition Chapter 12

2. Copyright 2002, Pearson Education Canada2 Partial Equilibrium Analysis zPartial equilibrium analysis refers to the process of examining the equilibrium conditions in individual markets and for households and firms separately.

3. Copyright 2002, Pearson Education Canada3 General Equilibrium and Efficiency zGeneral equilibrium is the condition that exists when all markets in an economy are in simultaneous equilibrium. zEfficiency is the condition in which the economy is producing what people want at least possible cost.

4. Copyright 2002, Pearson Education Canada4 Technological Change and the Economy zA significant - if not sweeping - technological change in a single industry affects many markets. Households face a different structure of prices and must adjust their consumption of many products. Labour reacts to new skill requirements and is reallocated. Capital is also reallocated.

5. Copyright 2002, Pearson Education Canada5 Cost-Saving Technological Change in the Calculator Industry As technology made it possible to produce at lower costs in the calculator industry, cost curves shifted downwards. As new firms entered the industry and existing firms expanded, output rose and market price dropped.

6. Copyright 2002, Pearson Education Canada6 General Equilibrium Impacts of a Shift in Consumer Preferences (Table 12.1) Consumer preferences in Canada shifted dramatically towards wine between 1965 and 1980. This has dramatic effects on a two industry economy; wine industry (X) and other industries (Y).

7. Copyright 2002, Pearson Education Canada7 Adjustment in an Economy with Two Sectors: Wine Industry Impact (Figure 12.3) Initially, demand for X shifts from D 0 x to D 1 x. This shift pushes the price of X up to P 1 x, creating economic profits. Firms enter and expand in sector X which shifts supply to S 1 x, reducing price and eliminating profits.

8. Copyright 2002, Pearson Education Canada8 Adjustment in an Economy with Two Sectors: Other Industry Impact (Figure 12.3) Initially, demand for Y shifts from D 0 y to D 1 y. This shift pushes the price of Y down to P 1 y, creating economic losses. Firms exit sector Y which shifts supply to S 1 y, increasing price and eliminating the losses.

9. Copyright 2002, Pearson Education Canada9 Allocative Efficiency and Competitive Equilibrium zCompetitive Market Assumptions yBoth output markets and input markets are perfectly competitive. yFirms and households are price takers. yHouseholds have perfect information and firms have perfect knowledge. yDecision-makers consider all costs and benefits; there are no externalities.

10. Copyright 2002, Pearson Education Canada10 Pareto Efficiency zPareto efficiency is a condition in which no change is possible that will make some members of society better off without making some other members of society worse off

11. Copyright 2002, Pearson Education Canada11 The Three Basic Questions of a Competitive Economy z What will be produced? z How will it be produced? z Who will get what is produced?

12. Copyright 2002, Pearson Education Canada12 Efficient Allocation of Resources under Perfect Competition zFirms have incentives to use the best available technology. zIndividual firms maximize profits, and so they must minimize costs. zEach firm uses inputs such that MRP a = P a. zTherefore, the marginal value of each input to each firm is just equal to its market price.

13. Copyright 2002, Pearson Education Canada13 Efficient Distribution of Outputs under Perfect Competition zHouseholds shop freely in the same markets. zHouseholds attempt to maximize their own utility. zEach household maximizes utility where MU a / MU b = P a / P b. zTherefore, the marginal rate of substitution for each household is equal to the price ratio.

14. Copyright 2002, Pearson Education Canada14 Efficient Mix of Output under Perfect Competition zFirms find their profit maximizing levels of output where MC = P. zMC represents the marginal value of the other things that could be produced with the same resources. zP represents the marginal value of the product to society. zUnder these conditions no changes can improve social welfare.

15. Copyright 2002, Pearson Education Canada15 Market Failure zA market failure occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost value.

16. Copyright 2002, Pearson Education Canada16 Sources of Market Failure z Imperfect competition z Public goods z Externalities z Imperfect information

17. Copyright 2002, Pearson Education Canada17 Imperfect Competition zImperfect competition refers to an industry in which single firms have some control over price and competition. Imperfectly competitive industries give rise to an inefficient allocation of resources. zA monopoly is an industry comprised of only one firm that produces a product for which there are no close substitutes and in which significant barriers exist to prevent new firms from entering the industry.

18. Copyright 2002, Pearson Education Canada18 Public Goods zPublic goods, or social goods are goods or services that bestow collective benefits on members of society; they are, in a sense, collectively consumed. zGenerally, no one can be excluded from their benefits. zClassic example: national defense.

19. Copyright 2002, Pearson Education Canada19 Externalities zAn externality is a cost or benefit resulting from some activity or transaction that is imposed or bestowed upon parties outside of the activity or transaction.

20. Copyright 2002, Pearson Education Canada20 A Classic Example of a Negative Externality is Air Pollution CountryMetric Tonnes per person Canada13.8 United States20.0 Germany10.5 China 2.8 India 1.1 Chad 0.0

21. Copyright 2002, Pearson Education Canada21 Imperfect Information zImperfect information is the absence of full knowledge regarding product characteristics, available prices, and so forth. zThe absence of full information can lead to transactions that are ultimately disadvantageous. zBuyers of services that require expertise often have imperfect information e.g. car repair.

22. Copyright 2002, Pearson Education Canada22 Review Terms & Concepts zefficiency zexternality zgeneral equilibrium zimperfect competition zimperfect information zmarket failure zmonopoly zPareto efficiency zPareto optimality zpartial equilibrium analysis zprivate goods zpublic goods